Editor’s Note: What follows is the executive summary of the February 2013 issue of Canadian Edge. Thanks for reading. — RSC

Canadian banks are at “elevated” risk to a global systemic shock because of high exposure to consumer loans.

That’s the opinion of credit rater Moody’s, which last month cut ratings on six of the country’s seven largest financial institutions.

Not surprisingly, that statement was swiftly denounced by Finance Minister Jim Flaherty, who pointed out in his own statement that the World Economic Forum has ranked Canadian banks the soundest in the world five years running.

Mr. Flaherty also noted that the country’s system is well regulated and reiterated the government’s effort to “ensure the long-term stability” of its housing market.

To be sure, Canada’s housing market is slowing, with home sales tumbling 20 percent in major cities last month. But that’s in large part due to much tougher standards for mortgage lenders as well as a cut in the period for a government-insured mortgage to 25 years from 30 years.

The country has no mortgage tax deduction, and putting 20 percent down on purchases is the rule. As a result, two necessary conditions of the 2007-09 housing collapse in the US–speculative “flipping” of properties and subprime loans–are at most extremely rare.

Titanic collapses like 2007-09 don’t occur back to back for one simple reason: Enough players act to protect themselves from a repeat. In this case it’s very hard to argue Canadian banks haven’t been insulating themselves from potential real estate weakness for some months. That’s even true in the once red-hot market for large city condominiums.

The upshot is worries about a 2008-style crash for Canada’s real estate and financial system are overwrought to say the least.

Rather, the primary concern for investors a month into 2013 is at the individual company level.

And the key question is how well underlying businesses are measuring up to the challenges of a slow growth North American economy, now taking a large dose of austerity.

Oil production is one problem area now. The price gap, or “differential,” between black gold produced in Alberta and in Texas is at an historic high, as surging output has at least temporarily swamped the means to transport it to market.

Canada’s health care, restaurants, food services and natural resource companies also face headwinds, as prices and fees are dampened by tepid demand and competition.

And the Canada Revenue Agency is apparently trying to claw back taxes from former income trusts now organized as corporations.

On the plus side, austerity in the US isn’t as severe as it first appeared. That’s a big positive for Canadian companies that have expanded southward. And the Canadian dollar has been able to hold rough parity with the US dollar, even on days when the buck has been strong elsewhere.

One month does not a trend make, but so far in 2013 the pluses seem to be outweighing the minuses for our Canadian Edge Portfolio Holdings, largely thanks to conservative operating and financial policies.

We’ll know a lot more about how they’re doing in the coming weeks, as they report fourth-quarter and full-year 2012 results. And, as always, we’ll let the numbers and developments be our guide for whether to buy, hold or sell.

At the top of my list of lessons from last year is to avoid stocks backed by businesses that don’t have a record of paying reliable dividends. But so long as companies support dividends and growth with their numbers, we’ll be sticking around, even if the share price action is soft.

Many investors forget that one year’s worst performers often lead the pack the next. That was the case for Parkland Fuel Corp (TSX: PKI, OTC: PKIUF) and TransForce Inc (TSX: TFI, OTC: TFIFF) in 2012. And so long as they perform as businesses, it should be true of last year’s underachievers.

Roger Conrad
Editor, Canadian Edge

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Portfolio Update

 

There are no new buys or sells in the Canadian Edge Portfolio this month.

I have made two changes. I’ve upgraded IBI Group Inc (TSX: IBI, OTC: IBIBF) to a buy below USD8 and reduced Colabor Group Inc (TSX: GCL, OTC: COLFF) to a hold. As we head into earnings season, I’m generally happy with the Portfolio lineup.

Four Holdings– ARC Resources Ltd (TSX: ARX, OTC: AETUF), Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF), Cineplex Inc (TSX: CGX, OTC: CPXGF) and Shaw Communications Inc (TSX: SJR/B, NYSE: SJR)–have once again demonstrated their ability to build wealth for the long term with solid operating results.

Portfolio Update highlights companies that have reported fourth-quarter and full-year 2012 earnings so far. Look for discussion of numbers from the rest of the Portfolio in Flash Alerts over the coming weeks as well as in the March issue, which will be published on March 8.

 

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Best Buys

Artis REIT (TSX: AX-U, OTC: ARESF) is a diversified property owner, with a primary focus on Western Canada. Management has put the pieces in place for the REIT’s first distribution increase since May 2008, which should earn Artis a higher valuation.

The current yield of nearly 7 percent is solid, there are no near-term debt refinancing worries and the company draws a perfect “6” under the CE Safety Rating System. Artis–also potential takeover target–is selling at just one times book value, as institutional Canadian property ownership continues to consolidate. Artis REIT is a buy up to USD16 for those who don’t already own it.

Just Energy Group Inc (TSX: JE, NYSE: JE) is a retail marketer of electricity and natural gas in unregulated US states and Canadian provinces. The company locks in customers to multi-year, price-protected contracts, which it matches with multi-year, price-protected energy purchase contracts.

The 12 percent-plus yield conveys Bay Street skepticism about the dividend, which management continues to affirm. But even in a worst-case there’s a very low bar of expectations that won’t be hard to hurdle.

Just Energy is a buy up to USD11 for those who don’t already own it.

Best Buys–which features the top two candidates for purchase in February–is the place to start if you have money to put to work right now.

 

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In Focus

As in the US, oil and natural gas drilling is booming in Canada. Unfortunately, infrastructure needed to get this energy to market is sorely lacking, resulting in a severe glut in underserved regions.

The crash in natural gas prices in early 2012 has partly reversed, as has the slide in natural gas liquids (NGLs) pricing. Oil prices, however, are now slumping, particularly in Alberta, where production is vastly outpacing the means to get it to US Gulf Coast refineries.

The long-run solution is to build infrastructure, including facilities to export liquefied natural gas (LNG). And the opportunities are huge for energy midstream companies. But because such projects can take years to complete, producers have to adapt now.

In Focus examines the challenge of widening price differentials, the potential damage to producers’ profitability, the building effort to get Canadian energy to market and, of course, how to play energy patch winners and losers.

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Dividend Watch List

Three How They Rate companies announced dividend cuts last month.

Bonavista Energy Corp’s (TSX: BNP, OTC: BNPUF) 41.7 percent reduction is the result of a decision to push ahead with an aggressive drilling program despite weak Canadian energy prices. The market anticipated the move. Buy up to USD15.

CML Healthcare Inc’s (TSX: CLC, OTC: CMHIF) 29.8 percent cut includes a move to quarterly payments and accompanies management’s decision to exit the diagnostic imaging business. Hold.

Westshore Terminals Investment Corp (TSX: WTE, OTC: WTSHF) is suspending payments entirely until it’s able to ascertain the cost of repairing the damage caused by a ship smashing into its primary facility. Rebuilding is expected to be complete by the end of April, which means the next dividend will probably be paid in July. Hold.

Dividend Watch List has more on the three cutters as well as details on other vulnerable members of the coverage universe.

 

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Canadian Currents

This is much unlike the rush of the 2000s. But four companies that look a lot like the Canadian income trusts we knew and loved have debuted on the Toronto Stock Exchange since November 2010.

Canadian Currents introduces three oil and gas producers and one electricity and natural gas retailer with US-based assets and Canadian legal organization that allow them to pay outsized distributions.

Bay Street Beat–Analysts on Canada’s equivalent to Wall Street have been active over the past month, changing recommendations and/or adjusting 12-month target prices for a number of Canadian Edge Portfolio Holdings, some that have reported recent financial and operating results and some that have not.

Bay Street Beat has the latest on what analysts are thinking about our favorites.

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How They Rate Update

 

Coverage Changes

Progress Energy Resources Corp is now part of Malaysia’s national oil and gas company Petroliam Nasional Berhad, better known as Petronas. Shareholders should by now have received CAD22 per share in cash.

The acquisition of PRT Growing Services Ltd by a private capital firm has also been consummated, with PRT holders receiving CAD4.45 per share in cash. Both companies are now delisted from How They Rate.

New to coverage this month are Canadian Utilities Ltd (TSX: CU, OTC: CDUAF) under Electric Power, Exchange Income Corp (TSX: EIF, OTC: EIFZF) under Business Trusts and Leisureworld Senior Care Corp (TSX: LW, OTC: LWSCF) under Health Care.

All three are rated hold. I’ll evaluate them for upgrades as they report earnings over the next few weeks.

Advice Changes

Avalon Rare Metals Inc (TSX: AVL, NYSE: AVL)–To Hold from Buy @ 4. The rare earths firm faces make-or-break results from a feasibility study of its Nechalacho mine in Canada’s Northwest Territories sometime in the second quarter. Let current bets ride with this speculation.

Colabor Group Inc (TSX: GCL, OTC: COLFF)–To Hold from Buy @ 10. Until there’s more clarity on the Canada Revenue Agency’s attempted claw-back of taxes from the company’s conversion to a corporation the wholesaler and distributor of food and non-food products is a hold.

Contrans Group Inc (TSX: CSS, OTC: CTFIF)–To Buy @ 10 from Hold. Plans to raise the distribution by 25 percent are a sign of strong health at this niche freight transportation provider, and takeover candidate.

Enerplus Corp (TSX: ERF, NYSE: ERF)–To Buy @ 14 from Hold. This well-managed company is dealing with oil-price differentials in the Bakken region by utilizing rail. That should enable it to generate sufficient cash flow in 2013 to pay its CAD0.09 per share monthly dividend and fund capital spending.

Genivar Inc (TSX: GNV, OTC: GNVUF)–To Buy @ 22 from Hold. The 7 percent yield seems solid as the engineering services firm continues to win and hold contracts.

IBI Group Inc (TSX: IBG, OTC: IBIBF)–To Buy @ 8 from Hold. The lower dividend is conservative, and refinancing debt is no longer a concern. The share price also appears to have stabilized after a series of upgrades on Bay Street, and insiders have increased holding by 14.1 percent the past six months, a vote of confidence in the company’s long-run prospects.

New Flyer Industries Inc (TSX: NFI, OTC: NFYED)–To Hold from SELL. A CAD116 million strategic investment by Brazil-based bus body manufacturer Marcopolo SA (Brazil: POMO3) provides much-needed financial support, even as the company seems to be having better luck winning orders for new buses.

Pace Oil & Gas Ltd (TSX: PCE, OTC: PACEF)–To SELL from Hold. At least one large shareholder opposes the company’s merger with AvenEx Energy Corp (TSX: AVF, OTC: AVNDF) and Charger Energy Corp (TSX: CHX, OTC: SVWYF).

But given the oil and gas producer’s small size, exposure to price differentials and approaching debt maturities the effort will likely prove futile. And the post-merger entity will still be small and vulnerable.

Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)–To Hold from SELL. There’s dividend risk here in 2013 despite management’s assurances. But a very low valuation counts for something with a company that’s still financially healthy.

Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE)–To Hold from SELL. Cutting back capital spending plans for 2013 can’t help but strengthen the dividend in a tough year, and this company arguably trades for less than 50 cents per dollar of reserves.

Primaris Retail REIT (TSX: PMZ-U, OTC: PMZEF)–To SELL from Hold. The retail property owner’s two suitors, H&R REIT (TSX: HR, OTC: HRUFF) and private capital firm KingSett Capital, have ended the bidding war by reaching a deal to divide ownership that includes RioCan REIT (TSX: REI-U, OTC: RIOCF).

Primaris unitholders will have the choice of taking CAD28 per share in cash or 1.166 units of H&R. The cash price represents a 2 percent premium over Primaris’ current price. The stock exchange value is a slight discount.

As the cash portion is limited, the actual payout will be a mix. Barring a big move in H&R, the take will be roughly equal to Primaris’ current price, leaving no incentive to hold until close.

WestJet Airlines Ltd (TSX: WJA, OTC: WJAFF)–To Buy @ 22 from Hold. Another blow-the-doors-off quarter earns this company a much higher buy target, as does the accompanying 25 percent dividend increase.

Record capacity in January is a good sign there’s a lot more to come, though investors should take care that airlines are rarely if ever good long-term investments.

Ratings Changes

Colabor Group Inc (TSX: GCL, OTC: COLFF)–To 3 from 4. The Canada Revenue Agency wants some claw-back on taxes from the company’s conversion to a corporation. The fallout should not affect efforts to grow or pay dividends, but the investigation does affect future earnings visibility until there’s a resolution.

Cominar REIT (TSX: CUF-U, OTC: CMLEF)–To 5 from 4. Longer-term earnings visibility improves with every accretive acquisition and debt refinancing this year and next should cut interest costs.

MEG Energy Corp (TSX: MEG, OTC: MEGEF)–To 2 from 1. The company’s development is still only in its infancy. But solid fourth quarter results provide some favorable visibility into the future and debt is low.

New Flyer Industries Inc (TSX: NFI, OTC: NFYED)–To 2 from 1. The CAD116 million strategic investment by Brazil-based bus body manufacturer Marcopolo SA (Brazil: POMO3) eliminates near-term financial risk and may eventually set the company on track for a return to growth.

Superior Plus Corp (TSX: SPB, OTC: SUUIF)–To 3 from 2. Management has eliminated near-term debt refinancing risk as a concern, and the payout ratio remains quite conservative.

Westshore Terminals Investment Corp (TSX; WTE, OTC: WTSHF)–To 3 from 4. The financial fallout from a ship crash into the company’s port facilities was worse than initially stated. Management won’t pay a dividend until repair costs are fully known, which likely means no payout until July.

Safety Ratings

The core of my selection process is the six-point CE Safety Rating System, which awards one point for each of the following. A rating of “6” is the safest:

• Payout Ratio–A ratio below our proprietary industry baseline.
• Earnings Visibility–Earnings are predictable enough to forecast a payout ratio below our proprietary industry baseline.
• Debt-to-Assets Ratio–A ratio below our proprietary industry baseline.
• Short-Term Debt Ratio–Debt due in next two years is less than 10 percent of market capitalization.
• Business Stability–Companies that can sustain revenues during recessions are favored over more cyclical ones.
• Dividend History–No dividend cuts over the preceding five years.

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Resources

 

The following Resources may be found in the top navigation menu at www.CanadianEdge.com:

• Ask the Editor–We will reply to your queries via email or in an upcoming article.
• Broker Guide–Comparison of brokers for purchasing Canadian investments.
• Getting Started–Tour of the Canadian Edge website and service.
• Cross-Border Tax Guide–What you need to know about taxes and Canadian investments.
• Other Websites–Links to other websites to help you get the most out of your Canadian stocks.
• Promo Stocks–Guide to the mystery stocks we tease in our promotional messages.
• CE Safety Rating System–In-depth explanation of the proprietary ratings system and how to use it effectively.
• Special Reports–The most recent reports for new subscribers. The most current advice is always in your regular issue.
• Tips on DRIPs–Details for any dividend reinvestment plan offered by Canadian Edge Portfolio Holdings.